Netflix - Equity Research Report PDF

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Summary

Example of a Equity Research Report required for the coursework (20% of Grade)...

Description

BF3204: FINANCIAL MODELLING WED CLASS GROUP 1 COMPANY:

S/N

Student Name

Matriculation Number

1

AGARWAL AROMA

U1911922K

2

ANG XIANG HUI, DAMIEN

U1911332D

3

ANG YONG KEONG CLEMENT

U1830740F

4

AU YI CONG, BENJAMIN (Submitter)

U1810392D

5

BENEDICT FOONG

U1910762E

6

BRYAN MOH JUN LIANG

N2000386E

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Table of Contents Executive Summary ................................................................................................................................... 3 Investment Highlights ................................................................................................................................ 4 Business Description ................................................................................................................................. 5 Macroeconomic Landscape...................................................................................................................... 6 Industry Overview & Competitive Positioning ........................................................................................ 7 Porter’s Five Forces ............................................................................................................................... 8 Valuation ...................................................................................................................................................... 9 Costs of Capital .................................................................................................................................... 11 1)

Cost of Debt .............................................................................................................................. 11

2)

Cost of Equity............................................................................................................................ 12

3)

Estimating Market Risk Premium ........................................................................................... 13

4)

Market Value of Debt and Equity ........................................................................................... 13

5)

Calculating the Weighted Average Cost of Capital ............................................................. 14

Income statement Assumptions ......................................................................................................... 15 Balance Sheet and Cash Flow Assumptions ................................................................................... 15 Valuation Methodologies ..................................................................................................................... 16 Perpetuity Growth Method .............................................................................................................. 16 Exit Multiple Using EV/Revenue .................................................................................................... 16 Exit Multiple Using EV/EBITDA ...................................................................................................... 16 P/E Ratio Based on Peers .............................................................................................................. 16 Netflix Football Field Analysis ............................................................................................................ 17 Senstivity Analysis ............................................................................................................................... 17 Scenario Analysis ................................................................................................................................. 19 Appendices................................................................................................................................................ 21 References ................................................................................................................................................ 22

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Executive Summary In this report, we recommend a “BUY” on Netflix, Inc (NASDAQ: NFLX) with a target price of USD 656.50, representing a 26.73% upside from the close price of USD 518.02 on 12th March 2021. Netflix, Inc was founded in 1997 by Reed Hastings and Marc Randolph and is a market leader in the Streaming Video on-Demand (SVOD) industry with 203.67 million subscribers in Q4 2020. The company offers TV Series, Documentaries and Movies across different genres and languages in over 190 countries. With their Mission “To entertain the world” and their Vision “To continue being one of the leading firms of the internet entertainment era”, Netflix aims to maintain its position as a market leader in the SVOD industry by offering high quality content for its consumers. Our “BUY” recommendation is founded on three main drivers. Firstly, we are confident in Netflix’s ability to produce high quality original content. Secondly, positive free cash flow in FY2020 coupled with Netflix’s sustainable business model allow for Netflix’s expansion. Finally, the SVOD industry remain largely untapped and provides Netflix with the opportunity for strong growth. The valuation of Netflix is done using its market value WACC of 9.07%, which reflects the investors’ current and forward-looking expectations for Netflix. To achieve a forecast of higher accuracy, we took a blended approach of four different valuation methodologies in calculating the value of Netflix’s share price. The methods involve the use of the Perpetuity Growth Model, EV/Revenue, EV/EBITDA and P/E ratio to derive our weighted average price for Netflix. We have also identified several risk factors and uncertainties that Netflix is subjected to. These risk factors and uncertainties form the basis for our sensitivity analysis, and how Netflix’s share price is affected. Key investment risks include inappropriate SVOD content which may offend consumers, account sharing between consumers leading to a lower subscription rate and the risk of traditional media outlets pulling their content from Netflix.

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Netflix Inc. | NASDAQ: NFLX

BUY

Streaming on Demand; A Media Powerhouse

Investment Highlights Innovation Drives Quality Original Content Netflix’s differentiating factor lies in that they are capable of churning out large number of original and extremely popular content. With over 500 titles currently in post-production, Netflix plans to release at least one new original film every week in 2021. Original content unique only to Netflix drives users to its platform and creates a sticky product that is hard to get rid of. It is clear that Netflix should have no problem staying as the industry leader; growing and retaining its subscriber base. Rosier Free Cash Flow Position: Sustainable Business Model The downside of producing large amount of incredible original content means that Netflix has been operating at a negative free cash flow (FCF) position ever since 2014. Most recently, however, Netflix has managed to prove its business model sustainable in 2020 with a 1.92B FCF-positive position. While that was in part due to lowered production cost in 2020 since Covid-19 forcefully halted productions of many films, Netflix has since told its shareholders that it is expecting to organically manage to achieve breakeven FCF position in 2021 despite the 500 new titles it is undertaking. Netflix has stated that “we believe we no longer have a need to raise external financing for our day-to-day operati ons” while simultaneously are exploring the possibility of stock buybacks. Subscription-Based Model & Large TAM to Drive Growth According to a report by Zuora, the subscription business have outpaced traditional businesses in the S&P500 by 6.5 times in terms of revenue since 2012. Netflix is posed to benefit as consumers and businesses demonstrate a growing preference for subcription services over product ownership. Our estimates also reveal a large addressable market in the International Region, thus suggesting high upside to Netflix’s topline moving forward. Valuation Method As Netflix does not have a history of distributing dividend, common valuation method such as the Dividend Discount Model cannot be used in our valuation. To achieve a forecast of higher accuracy, we take a blended approach of four different valuation methods to derive the value of Netflix’s share. The first method involves the use of the Perpetuity Growth Model, where the equity value is derived from the present value of future FCF and terminal value. The remaining three methods involves the use the exit multiples (EV/Revenue and EV/EBITDA) and P/E ratio of comparable firms to derive the equity value of Netflix.

Price Target

USD 656.50

Close (12 Mar 2021)

USD 518.02

Upside/Downside

+26.73%

Industry: Consumer Discretionary - Media Bloomberg Ticker: NASDAQ: NFLX Key Statistics 52-Week High (USD) 52-Week Low (USD)

593.29 290.25

Shares Outstanding (b) Market Cap (USD b) Average Daily Volume (m)

441.8 228.71 4.71

Share Float (b) Book Value/Share (mrq)

437.06 24.98

Debt to Equity (mrq) Return on Equity (ttm)

167.29 29.62%

Top 5 Shareholders (%) Capital Research & Mgmt

13.51

The Vanguard Group BlackRock, Inc.

7.50 6.49

T. Rowe Price Group FMR LLC

4.39 4.37

Share Price Chart (1 Year)

Source: Capital IQ, Yahoo Finance Data Accurate as of 10 March 2021

By taking the average of the share price found using the four different methods, we arrive at our target price of USD 656.50.

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Business Description Netflix Inc. (“Netflix” or “The Company”) is an entertainment services company. The company offers TV Series, Documentaries, and Movies across different genres and languages in over 190 countries. Netflix allows subscription members the ability to access streaming on-demand through internet-connected devices. It also provides DVD-s by mail membership services. The company was incorporated in 1997 in Delaware, the United States. Its revenue is a function of its subscribers and the fee they pay which varies by country and the features of the plan. Pricing on its plans ranges from $3 to $23 per month. Members can watch content from Netflix through any Internet-connected device that offers the Netflix application, including smart TVs, game consoles, streaming media players, set-top boxes, smartphones, and tablets. The Company acquires, licenses, and produces content, including original programing. Business Segments. In 2007, Netflix has become a pioneer in introducing streaming video on-demand (SVOD). Since its launch, the Company has developed a synergistic ecosystem of interconnected internet devices and have since expanded its amount of content to attract larger audiences to its platform. As of the fourth quarter of 2019, Netflix operates one large business segment – With revenues derived from monthly streaming subscription fees from its global customers.

Figure 1: Growing users locally and internationally

Figure 2: Netflix’s Position as a Market Leader Source: 2019 Annual Report, Business of Apps

Position against Competitors. Netflix’s audiences stems largely from the international crowd, accounting for more than half of their paid subscribers quarteron-quarter. Since Q4 2019, they have been able to increase their users from 167.09 million to 203.67 million, representing a 21.9% increase year-over year (Figure 1). Over the years, the streaming industry has become increasingly saturated, However, the Company’s first mover advantage has allowed them to lead the market against competitors such as Disney+ and Amazon Prime. Additionally, their core strategy of continuously innovating new content and enhancing their user interfaces allows them to maintain their leading position. Figure 2 shows the estimated total subscribers for Netflix and its respective competitors. While Netflix currently leads the pack with 204 million subscribed users, its competitors have slowly gained market share with Amazon Prime and Disney+ not far behind – with 150 million and 87 million subscribers respectively. It remains to be seen how Netflix fares against new entrants in the market in the future as the global economy recovers from the Covid-19 pandemic.

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Macroeconomic Landscape V(accine)-Shaped Narrative Prevails. The vaccine recovery will continue to be a recurring theme for many countries in 2021. Analysts are expecting a stronger than expected economic recovery due to a dovish Fed – allowing for easy monetary & fiscal policy. According to Goldman Sach’s 2021 Outlook (Figure 3), they expect global economies to register positive real GDP growth in 2021, with emerging markets such as China leading the pack.

Figure 3: 2021 Macroeconomic Outlook

Recent economic data suggests that global economies are recovering faster than expected as well; unemployment rates in the U.S. fell to 6.3% in January 2021 compared to the high of 14.7% in April 2020. Thus, indicating that we are seeing growing economic activity as vaccine rollouts gain traction (Figure 4) and people adjust to new normals of working. At the same time, we are seeing unprecedented levels of fiscal and monetary policy. With the USD 1.9 trillion fiscal stimulus recently approved by the House, there is no doubt that reflation will be buzzword on how global financial markets and the economy will behave in the year of 2021. In fact, evidence of such is currently being priced into the forward-looking financial markets.

Figure 4: Daily new Covid-19 Cases

Sector Rotation from Growth to Value. 2020 represented an extraordinary year for the financial markets. Growth equities from the technology sector have massively outperformed because of low interest rates and a boost to earnings due to increased spending by consumers who worked from home. Meanwhile, valueoriented sectors such as financials and retails have suffered due to the lack of business as consumers stay at home. However, expectations of a full economic recovery as seen from rising 10-year treasury yields (Figure 5) sparked a sector rotation from growth equities to value-oriented equities. The excess consumer expenditure brought technology spending forward and could result in a demand shortfall. This caused a massive sell-off in the technology sector as funds and retail investors scramble to sell over-valued technology stocks – many that have yet to generate positive earnings and cashflows – to traditional, cyclical oriented stocks.

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Fear is the Door to Opportunity. While many funds and retail investors rebalance their portfolio in fear – causing many technology equities to sell off – we believe this represents a contrarian opportunity for Netflix as individuals start to find value expensive and technology equities trading at much attractive price points. Therefore, it is important to understand the industry that Netflix is in to better forecast its performance in the future.

Industry Overview & Competitive Positioning According to a report by Grand View Research, the global video market it still in its infancy stages, the industry is expected to expand at a calculated annual growth rate (CAGR) of 21% from 2021 to 2018. We believe there are three key catalysts driving this change: Subscription Services Here to Stay. The prospect of the streaming industry is bright and promising. Over the past few years, businesses have shifted their growth strategies to accommodate to consumers’ preference for subscription services rather than owning the product. For businesses to grow, they must now focus on monetizing on creating value and maintaining long-term relationships rather than charging a onetime fee for a product.

Figure 6: Subscription Economy Index (SEI)

In a study by Zuora (Figure 6), they found that 51% of the companies surveyed in the U.S., U.K, and Australia have changed the way they are delivering their goods & services.

Additionally, they also found that subscription businesses grew revenue six times faster than traditional businesses in the S&P 500. Companies in the streaming industry rely heavily on subscription services as their source of revenue and hence are poised to benefit as businesses shift towards subscription-based business models to retain its customers. Large Serviceable Obtainable Market (SOM). While Netflix currently leads the market in terms of total paid subscribers, there still exists a large untapped market globally. Our research suggests that Netflix has only touched the tip of the iceberg when you look at the total addressable market (Figure 7).

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Figure 7: Untapped Market Potential for Netflix

To determine the total addressable market (TAM), we looked up the total population figures for each region and divided the population according to its average household size, assuming that each household owns one Netflix subscription. It is also important to note that we excluded China’s population in the Asia Pacific region as they likely would not subscribe to Netflix, but rather, use other entertainment sources from the mainland market (i.e. Bilibili, Youku, etc.). Estimates for the percentage of households that can afford Netflix are obtained by taking the household size for each region multiplied by its corresponding internet penetration rate. Therefore, we can obtain figures for the Serviceable Addressable Market (SAM). Finally, deducting the current subscribers as of 2020 from SAM, we obtain a Serviceable Obtainable Market (SOM) of 1542 million households worldwide that have yet to subscribe to Netflix. As you can see, the penetration rate of Netflix globally stands at approximately 13%. This represents huge upside in terms of top-line and bottom-line performance if Netflix can capitalize on its strengths and becomes a dominant monopoly in the streaming industry. Disruptive Innovation: Artificial Intelligence (AI) and Blockchain. The synergistic nature of AI and Blockchain will unlock massive opportunities for differentiation in the streaming industry. While much has been published in academic papers on the theoretical uses of combining both cutting-edge technologies, its realworld application remains sparse at the moment. The potential for AI and Blockchain together is massive. For example, data can be stored on blockchain, which is highly secure because of cryptography. This is important because AI systems used to detect consumer preference for example, are highly sensitive and private in nature, that is where blockchain comes into the picture. Currently, Netflix leverages on data insights generated by AI to drive growth. The Company uses collected data points to understand their user preferences and recommends content to keep them glued to the screen. Additionally, AI is used to recruit top talent in the media industry, allowing them to drive quality content. According to Outside Insight, Netflix was able to recruit award-winning producer, director, and writer Ryan Murphy to the team. Of course, this was done using their AI systems. With that being said, Netflix has yet to explore blockchain to secure its data. This is important as cybersecurity rose to prominence in 2020; blockchain will be the next step for streaming companies to differentiate themselves. Porter’s Five Forces Rivalry within Industry – High The Streaming Video On-Demand (SVOD) market is currently dominated by a few large brands (Disney+, Amazon Prime), with Netflix being one of them. Additionally, low subscription costs allow many users to simultaneously have multiple accounts over different streaming...